Definition of ijarah

A trype of contract in Islamic finance.

Islamic financial institutions use ijarah contracts either as a lessor or a lessee. Some jurists define ijarah as ownership of the right to the benefit of using an asset for a period in return for a consideration.

Ijarah is classified into operating ijarah, which doesn’t include a promise to transfer the legal title of the leased asset into the lessee at the end of the lease, and ijarah muntahia bittamleek, which is concluded by passing the legal title of the leased asset to the lessee.

For the ijarah contract to be valid it must be preceded by acquisition of the asset (or the usufruct of the asset) to be leased by the institution (lessor). The ijarah contract is a binding contract which neither party may terminate or alter without the other’s consent.

The duration of the ijarah contract must be specified in the contract and normally commences on the date of executing the contract unless a future date is agreed by both parties. It is permissible that the Islamic bank requires the lease promissor (customer) to pay to guarantee the customer’s commitment to accept a lease on the asset and the subsequent obligations, provided no deduction to be made to this sum except for damages suffered by the bank as a result of the customer’s breaching his promise.

No rental will be due if the lessor fails to deliver the asset to the lessee on the date specified in the ijarah contract. At the end of the ijarah agreements the lessee has one of three options; either to return the leased asset to the lessor or to renew the lease contract for another term or to purchase the leased asset for a price that is determined based on rental payments made by the lessee.

In the Islamic bank’s financial statements, the assets acquired for ijarah shall be recognised at historical costs that include its net purchase price plus other expenditures necessary to bring the asset into its intended use. Ijarah revenue (when the Islamic bank is a lessor) and expense (when the Islamic bank is a lessee) are recognised when the ijarah instalment becomes due. Normally the lessor will be responsible for major repairs (other than periodic ones; which are borne by the lessee) unless they are the result of the lessee’s misuse or misconduct. The Islamic bank should disclose the accounting policies adopted for operating ijarah and ijara muntahia bittamleek in the notes accompanying the bank’s financial statements. [1][2][3]